As financial markets move through economic cycles the focus of regulators often shifts to ensure current and potential risks are adequately assessed and mitigated against. In the current climate economic cycles are shortening and risks are becoming ‘game changers’ quicker.
Anyone close to the PRA will be aware that it has identified three key risks at the present time; funding/business model pressures, credit risk and operational resilience and recovery. The PRA and FCA move in tandem to require lenders to manage these risks responsibly, with the former focusing on prudential risk and the latter covering off conduct risk. For example, the PRA took the lead to ensure lenders appropriately assess affordability risk in buy to let lending while the FCA limits lenders’ moves up the risk curve with its Mortgage Market Review.
Despite these market interventions there has been a continuous move by many lenders up the risk curve. Recent trade publications contain headlines such as “lender x updates lending criteria”, “Criteria enhancements on lending to self-employed” or “Lender y announces residential affordability changes”. The changes, individually, do not contribute to a seismic shift in risk, but collectively there has been a creep in accepted credit risk and it is the cumulative effect of this ‘credit creep’ that regulators are reviewing.
Credit creep presents a significant risk to a business’s future (as happened in 2008/2009), but the additional issues of increasing funding costs and competition driving pricing down add to the risks. While many lenders have in recent times benefited from low cost Central Bank funding (FLS and TFS) these will soon have to be repaid and the replacement funds will be more expensive. It is not surprising then that ‘margin compression’ and the impact on ‘net interest margin’ is high on regulators’ agendas.
So, what are we finding?
- Lenders pushing the boundaries on credit and pricing to gain market share
- Funders focussing on lenders’ adherence to agreed criteria within funding lines
- Both lenders and funders re-focusing their efforts on robust independent reviews of underwriting processes and mandate holders decisioning
- Lending decisions ‘outside criteria’ or where ‘discretion’ is applied are back in the spotlight – individual underwriters’ performance is now being reviewed over longer time-frames.
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